FOB or CIF, That is the Question, Shakespeare

Some time ago, I wrote about the advantages a sophisticated exporter or importer would enjoy by taking note of the terms of sale that should be employed in international transactions.

An axiom in international trade that probably harks back to the ancient Phoenicians, states that you should buy FOB and sell CIF. The reason is fairly obvious, all things being equal. An FOB purchase “presumably” covers only the cost of the goods at the FOB point (factory or port of exit, while CIF can include a myriad of items either actual or built up, unknown to the purchaser. Why then, do many importers accede to the seller’s CIF terms? Mostly its because of convenience. The seller arranges and is responsible for delivery to the discharge port. But at what cost? Especially since there are ample opportunities at point of origin to arrange shipping and other details subsequent to purchase. And at the same time, save some duty.

Here’s how. Under current US Customs law and regulation, the price of goods is usually the “transaction value” which is essentially defined as the total payment for the goods, “exclusive of any costs, charges or expenses incurred for transportation, insurance and related services incident to the international shipment of the merchandise…” These costs must be the actual ones-not estimates, and evidence, apart from the invoice for the goods, must be submitted to obtain a deduction from the invoice to arrive at a dutiable value. So if you ship CIF, these elements must be developed and evidence of payment submitted, in order to deduct the charges. This isn’t a problem with an FOB purchase since the charges aren’t in the selling price.

Of course, FOB can be a tricky term. To buy ex-works creates a problem for the buyer not familiar with the inner transportation techniques of, say, Korea. Easier, then to buy FOB Pusan and forgo a deduction for the freight from the factory to seaboard. But, if the supplier can furnish the importer with a copy of a trucking bill, the deduction will probably be allowed. And of course, the ocean freight is no longer a problem, since it is paid on this side.

Insurance is another problem. Most CIF shipments are insured under the seller’s marine policy, the rate for which is not easily identifiable. Customs has ruled that only independent evidence of actual payment will allow a deduction. Furthermore, there is a dimly understood IRS regulation that assesses an excise tax on insurance premiums paid abroad. FOB shipping, with insurance underwritten in the US avoids this complication, allows a deduction from Customs value and, incidentally, allows for quicker, more efficient claims payment.

The biggest deduction that can be allowed from a CIF price is, of course, the ocean freight. In days past, if you were buying CIF, it was an easy matter to contact the steamship agent and determine, from the ocean manifest, the amount of freight charged. Customs accepted this method, notwithstanding that the shipper may have paid a lesser amount. As long as there was a confirming number on the manifest, deduction could be made.

This is no longer true. The recent passage of the Ocean Shipping Reform Act provides for confidential agreements between carriers and shippers/consignees. Steamship lines don’t have to show the freight amount on bills of lading or manifests. When Customs was approached for a solution, they said, in effect, “too bad”; either produce evidence of what was charged or forgo the deduction.

A Hobson’s choice? You bet. Another bit of evidence to show that importing should be done on a FOB point of origin basis.

Ironically, however, the new law has little or no effect on the rest of the trading world. Virtually every one of our trading partners assess duties on a CIF price. (The U.S. has tried to conform to the rest of the world in the past but it didn’t work. Because of our size, the same goods would land at different prices all over the country). So exporters are in the driver’s seat in quoting CIF.

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